As the barrage of media coverage and the 2013 proxy season results show, shareholder activism is proliferating. Even large corporations are no longer immune from activist pressure: Shareholders have recently made demands on Apple and Dell, among others. Activist demands are increasingly being brought to shareholders at large, as activist investors introduce proxy proposals to either force corporate governance changes or, more frequently, to replace the incumbent board with a slate of directors more sympathetic to the activists’ reform objectives.
Historically, corporations have successfully fended off activist campaigns by using defenses—such as staggered boards and poison pills—designed to thwart the activist’s agenda. However, as activism continues to evolve into the mainstream of American corporate life, courts are increasingly scrutinizing and dismantling corporate defenses deemed to be inconsistent with fundamental notions of corporate democracy. One such highly scrutinized defense is the proxy put, also known as a “poison put.” These are indenture provisions that allow lenders to demand acceleration of bond redemptions upon the occurrence of certain events, such as a change in control brought about by the election of a dissident director slate. In its March 8, 2013 Kallick v. SandRidge Energy, Inc. decision, the Delaware Chancery Court examined a proxy put and ultimately prohibited SandRidge Energy, Inc. from interfering with hedge fund TPG-Axon Capital Management’s consent solicitation to replace SandRidge’s entire board of directors with an insurgent slate.
The TPG/SandRidge activist campaign
TPG, which owned approximately 7 percent of SandRidge’s shares, sent a fight letter to the company demanding various governance reforms and accusing SandRidge of underperformance due to strategic missteps and “appalling” corporate governance practices. SandRidge’s board responded by adopting a poison pill and amending the company’s bylaws to prevent shareholder action by written consent. TPG then launched a formal consent solicitation to declassify SandRidge’s board and replace all incumbent directors. In a consent revocation statement, SandRidge warned investors that replacing the incumbent board would constitute a change of control triggering an optional redemption right at 101 percent of par in the company’s outstanding $4.3 billion senior notes (the “Proxy Put”), and accelerating debt repayment would present an extreme and risky financial burden. Although the senior notes permitted SandRidge’s board to avert the Proxy Put by approving TPG’s director slate as legitimate nominees, the board refused to do so. A shareholder unaffiliated with TPG brought suit seeking an injunction ordering SandRidge’s board to “approve” TPG’s nominees for the limited purpose of defusing the Proxy Put.
Directors’ duty to approve a dissident slate
Chancellor Strine held that SandRidge’s board owed the company and its shareholders an affirmative duty to approve TPG’s slate and nullify the proxy put so long as the nominees did not pose a “specific and substantial risk” to the corporation or its creditors (e.g., nominees were not known looters, of suspect integrity, or truly incompetent), and approval of the nominees would not breach a contractual duty to the note holders. In reaching this conclusion, Chancellor Strine cited the court’s 2009 decision in San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc., which found that an incumbent board of directors acting in good faith may approve, without actually endorsing, a dissident slate for the purpose of defusing a poison put.
Chancellor Strine found no reasonable justification for refusing to approve TPG’s nominees and thus concluded that SandRidge’s directors likely breached their fiduciary duties. Chancellor Strine characterized the incumbent board’s actions as self-interestedness and redolent more of the pursuit of an incremental advantage in a close contest than of any good faith concern for the company, its creditors, or its shareholders. Furthermore, the mere belief that the incumbent board is better qualified and has better plans for the corporation than its rival nominees is not a sufficient reason to deny shareholders the opportunity to vote for a dissident slate.
SandRidge settled the litigation less than a week after the Chancery Court’s decision. In exchange for TPG’s termination of its consent solicitation, SandRidge added four of TPG’s nominees to the board of directors. Moreover, the settlement agreement provided that within four months, SandRidge would either terminate the chairman and CEO or remove three incumbent directors and allow TPG to appoint a fifth director, resulting in dissident directors constituting a majority of the board.
The future of shareholder activism
The SandRidge decision will echo through corporate boardrooms as incumbent directors consider their obligation to approve (but not endorse) a slate of directors proposed by an activist investor. Barring the unlikely circumstance that the board can articulate a basis by which the activist slate would pose a “specific and substantial risk” to the corporation, boards will be hard-pressed to avoid approving (particularly in the context of the poison put) the proposed slate for consideration by the shareholders at large. Traditional defenses — designed to avoid bringing the activist slate to shareholder vote — may be increasingly unavailable. This speaks to the need for a different corporate tactic, as boards consider the utility of engaging with activists rather than reflexively dismissing them. Failing to do so will quickly shift the activist battle to the courtroom, where directors acting reflexively and in ways inconsistent with fundamental notions of shareholder democracy may find a chilly reception waiting for them.